IPOs - Are you Investing Correctly?

It is raining IPOs on D-Street. The beauty and fashion retailer Nykaa’s IPO received strong subscriptions from investors, leading to oversubscription up to 82 times till day three. Similarly, investor bags also flocked towards the IPO of Fino Payments Bank, which got oversubscribed by 2.03 times. The fintech giant Paytm (One97 Communications Limited) launched the biggest IPO in the history of Indian capital markets, raising a massive INR 18,300 Cr. on 8th November, which definitely attracted bidders interest.

What is an IPO?

Initial Public Offering is the first time a company decides to offer its shares to the public, apart from private placement. The company has to file a request with the Securities and Exchange Board of India (SEBI) regarding the IPO launch with valid reasons why the company wants to go public. There must be a proper plan with the company regarding where the funds collected will be utilized and what are the objectives of raising finance.

The frequent IPOs in the Indian market has put questions in the mind of investors regarding what must be the best practices to wisely invest in IPOs in order to sustain profitability. Most often, IPOs provide a rough 50-100% return on the day they get listed on the exchanges (as it happened in the case of Nykaa). For example, the Zomato IPO which had a bid price of INR 76 was listed at INR 116, thus providing 52% return in just 3 days. Most excited investors just get fascinated by these charming returns and block their money in every IPO that is launched.

But this is not the case in every IPO, taking the example of the IPO of ICICI Securities, which had an issue price of INR 520, but due to its undersubscription, it got listed at INR 431.1 on the BSE. Thus, the demand of the shares play a vital role in determining the listing price of an IPO shares. However, certain other factors like unfavorable market conditions can also lead to lower list price. There a lot of technicalities that are need to be taken care of in order to reap benefits from IPO investing.

Category of Investors

IPOs are available for subscription to three categories – Qualified Institutional Buyers, High Net worth Individuals and retail investors. However, for a profit making company, retail investors can only subscribe upto 35% of the total shares on offer, whereas for a loss bearing company, this mark reduces to a mere 10%. For example, the IPO size of Zomato was INR 9375 Cr. aggregating a total of 72.92 crore shares on offer. So only 10% of 72.92 crore shares would be allotted to retail investors i.e. 7.292 crore shares and the balance would be distributed between the other two.

Being a retail investor, it is never sure that you will be allotted the same number of shares that you would have bid for. Generally most of the IPOs are oversubscribed due to the limited number of shares. In this case, the investors from QIB and HNIs enjoy the benefit of pro-rata allotment. But for allotting shares to the retail investors, it is done through a lottery system if even one lot cannot be allotted to each bidder. If an investor would have applied for one lot of Zomato (i.e. 76*195=14820), then it is not definite that he will get that lot. If he doesn’t succeed in the lottery then the whole amount will be refunded without any share allotment.

There may be different investing objectives of different investors when they decide to block their money in IPOs. Some might prefer to reap short term capital gains by selling the shares right after listing, while another set of people may prefer to hold the shares for a long term as the issue price is generally the lowest price at which the company’s share can be bought. Another investing objective can be tax linked, wherein a person may prefer LTCG over STCG as the latter is charged @15% and the former @10%, leading to tax saving as well as principal growth.

Red Herring Prospectus

It is always advised to go through the Red-Herring Prospectus of the company before putting your valuable money into a company who doesn’t have any public data. This prospectus doesn’t contain all details about the issue price of shares as the bidding process is about to start leading to a final issue price. The Red-Herring Prospectus includes significant information related to why the company needs financing from the public and in which objects will it utilize this money raised from the public. After having this awareness, the investor can independently make a decision regarding whether the company is trustworthy or not. It also contains the risks the company may face or is currently facing. The company lists down all the external and internal risk factors which may count from 50 to 100.

What is GMP?

Another important factor to consider before investment decision is the value of Grey Market Premium (GMP). Grey Market Premium is the price at which the company’s shares are being traded in the grey market. A grey market is a parallel market where individuals carry out deals based on mutual trust with no involvement of regulators like SEBI. The rates prevailing in the grey market is considered an important indicator as to how the stock will perform after listing. If the share is trading at a premium on the issue price, it is considered to be a positive sign for the stock performance. For example, the issue price of Zomato IPO was INR 76, but the share was trading in the grey market at an average of INR 103, witnessing a grey market premium of INR 27. Thus for an investor, it was a good sign in order to list gains in the stock exchange on Zomato IPO.

An IPO at instance may look exciting to retail investors, but there are risks and conditions attached to it as already discussed. A proper research about the company fundamentals, the management and team must be done before taking an informed decision. Most of the startup companies launching IPOs come out to be loss making, due to which it becomes very difficult to have faith on its financials and fundamentals in order to block some shares. This calls out for an informed research from the end of investors who is financially educated. If everything goes well and shares get allotted, IPOs are an excellent source of making out instant gains at listing and can even provide huge benefits if kept invested for a long period.